1. Organization and Summary of Significant Accounting Policies

AcelRx Pharmaceuticals, Inc., or the Company or AcelRx, was incorporated in Delaware on July 13, 2005 as SuRx, Inc., and in January 2006, the Company changed its name to AcelRx Pharmaceuticals, Inc. The Company’sCompany’s operations are based in Redwood City, California.

AcelRx is a specialty pharmaceutical company focused on the development and commercialization of innovative therapies for use in medically supervised settings. DSUVIA^®(known as DZUVEO in Europe) and Zalviso^®, areboth focused on the treatment of acute pain. AcelRx’s two product candidates, DSUVIA^™ (known as ARX-04 outside of the United States),pain, and ZALVISO^®, each utilize sublingual sufentanil, delivered via a non-invasive route of sublingual administration. Subjectadministration, exclusively for use in medically supervised settings. On November 2, 2018, the U.S. Food and Drug Administration, or FDA, approved DSUVIA for use in adults in a certified medically supervised healthcare setting, such as hospitals, surgical centers, and emergency departments, for the management of acute pain severe enough to obtaining regulatory approvals,require an opioid analgesic and for which alternative treatments are inadequate. In June 2018, the European Commission, or EC, granted marketing approval of DZUVEO for the treatment of patients with moderate-to-severe acute pain in medically monitored settings. AcelRx anticipatesis further developing a distribution capability and commercial organization in the United Statesto continue to market and sell DSUVIA in the United States. The commercial launch of DSUVIA in the United States by itself, and potentially,occurred in certain European Economic Area, or EEA, countries with strategic partners.the first quarter of 2019. In geographies where AcelRx decides not to commercialize products by itself, including for DZUVEO in Europe, the Company may seek to out-license commercialization rights. The Company currently intends to commercialize and promote DSUVIA/DZUVEO outside the United States with one or more strategic partners, although it has not yet entered into any such arrangement. The Company is currently evaluating the timing of the resubmission of the new drug application, or NDA, for Zalviso. AcelRx intends to seek regulatory approval for ZALVISOZalviso in the United States and, if successful, potentially promote ZALVISOZalviso either by itself or with strategic partners. Zalviso is approved in Europe and is currently being commercialized by Grünenthal GmbH, or Grünenthal.

DSUVIA/DZUVEO

DSUVIA, known as DZUVEO in Europe, approved by the FDA in November 2018 and approved by the EC in June 2018, is indicated for use in adults in a certified medically supervised healthcare setting, such as hospitals, surgical centers, and emergency departments, for the management of acute pain severe enough to require an opioid analgesic and for which alternative treatments are inadequate. DSUVIA was designed to provide rapid analgesia via a non-invasive route and to eliminate dosing errors associated with IV administration. DSUVIA is a 30 mcg sufentanil sublingual tablet insingle-strength solid dosage form administered sublingually via a single-dose applicator, intendedor SDA, by healthcare professionals. Sufentanil is an opioid analgesic currently marketed for intravenous, or IV, and epidural anesthesia and analgesia. The sufentanil pharmacokinetic profile when delivered sublingually avoids the treatmenthigh peak plasma levels and short duration of moderate-to-severe acute pain administeredaction observed with IV administration.

DSUVIA was approved with a Risk Evaluation and Mitigation Strategy, or REMS, which restricts distribution to certified medically supervised healthcare settings in order to prevent respiratory depression resulting from accidental exposure. DSUVIA is only distributed to facilities certified in the DSUVIA REMS program following attestation by an authorized representative to comply with appropriate dispensing and use restrictions of DSUVIA. To become certified, a healthcare professional.setting is required to train their healthcare professionals on the proper use of DSUVIA was initially developed atand have the requestability to manage respiratory depression. DSUVIA is not available in retail pharmacies or for outpatient use. As part of the U.S. Department of Defense as a replacement for injections of morphine on the battlefield. In addition to the military application, AcelRx is developing DSUVIA for the treatment of patients suffering from moderate-to-severe acute pain in multiple settings, such as emergency room patients; patients who are recovering from short-stay or ambulatory surgery and do not require more long-term analgesia; post-operative patients who are transitioning from the operating room to the recovery floor; certain types of office-based or hospital-based procedures; patients being treated and transported by paramedics. The Company completed the Phase 3 clinicalREMS program, for DSUVIA and in February 2017 a New Drug Application, or NDA, was accepted for filing by the U.S. Food and Drug Administration, or FDA, for DSUVIA for the treatment of moderate-to-severe acute pain to be administered by a healthcare professional in medically supervised settings. On October 12, 2017, the Company received a Complete Response Letter, or CRL, frommonitors distribution and audits wholesalers’ data, evaluates proper usage within the FDA regarding its NDAhealthcare settings and monitors for DSUVIA which states the FDA determined it cannot approve the NDA in its present formany diversion and provides recommendations for resubmission. The CRL contained two primary recommendations. First, while the safety database was suitable in number of patients, the collection of additional data was requested on at least 50 patients to assess the safety of DSUVIA dosed at the maximum amount described in the proposed labelling. Second, to ensure proper administration of the tabletabuse. AcelRx will de-certify healthcare settings that are non-compliant with the single-dose applicator, the FDA recommended certain changes to the Directions for Use to address use-related errors, including dropped tablets, which changes would need to be validated through a Human Factors study. AcelRx has requested a Type A post-action meeting with the FDA to discuss the topics covered in the CRL and expects to confirm plans to move towards resubmission of the DSUVIA NDA. In March 2017, the European Medicines Agency, or EMA, notified the Company that the ARX-04 (sufentanil sublingual tablet, 30 mcg) Marketing Authorisation Application, or MAA, has passed validation, and that the scientific review of the MAA is underway. The MAA for ARX-04 was filed for the treatment of patients with moderate-to-severe acute pain in a medically supervised setting. AcelRx expects an opinion on the MAA from the Committee for Medicinal Products for Human Use, or CHMP, in the first half of 2018.REMS program.

ZALVISOZalviso

ZALVISOZalviso delivers 15 mcg sufentanil sublingually through a non-invasive delivery route via a pre-programmed, patient-controlled analgesia,, or PCA, system. ZALVISOZalviso is approved in the EEA, Norway, Iceland and LiechtensteinEurope and is in late-stage development in the U.S.United States. The Company had initially submitted to the FDA an NDA seeking approval for ZALVISOZalviso in September 2013 but received a complete response letter, or CRL, on July 25, 2014. Subsequently, the FDA requested an additional clinical study, IAP312, designed to evaluate the effectiveness of changes made to the functionality and usability of the ZALVISOZalviso device and to take into account comments from the FDA on the study protocol. In the IAP312 study, for which top-line results were announced in August 2017, ZALVISOZalviso met safety, satisfaction and device usability expectations. These results will supplement the three Phase 3 trials already completed in the ZALVISOZalviso NDA resubmission. The Company remains on track foris currently evaluating the resubmissiontiming of the NDA resubmission for ZALVISO by the end of 2017 and intends to resubmit the ZALVISO NDA after the Type A post-action meeting with the FDA regarding the DSUVIA CRL.Zalviso.

On December 16, 2013, AcelRx and Grünenthal GmbH, or Grünenthal entered into a Collaboration and License Agreement, or the License Agreement, which was amended effective July 17, 2015 and September 20, 2016, or the Amended License Agreement, which grants Grünenthal rights to commercialize ZALVISOthe Zalviso PCA system, or the Product, in the countries of the European Union, or EU, Switzerland, Liechtenstein, Iceland, Norway and Australia (collectively, the Territory) for human use in pain treatment within, or dispensed by, hospitals, hospices, nursing homes and other medically supervised settings, or(collectively, the Field.Field). In September 2015, the European Commission, or EC approved the Marketing Authorization Application,marketing authorization application, or MAA, previously submitted to the European Medicines Agency, or EMA, for ZALVISOZalviso for the management of acute moderate-to-severe post-operative pain in adult patients. The approval allows Grünenthal to market ZALVISO in the 28 EU member states as well as for the EEA, Norway, Iceland and Liechtenstein, or EEA. Also onOn December 16, 2013, AcelRx and Grünenthal, entered into a related Manufacture and Supply Agreement, or the MSA, and together with the License Agreement, the Agreements. Under the MSA, the Company will exclusively manufacture and supply the Product to Grünenthal for the Field in the Territory. On July 22, 2015, the Company entered into an amendment toand Grünenthal amended the MSA, or the MSA Amendment, and together with the MSA, the Amended MSA, between the Company and Grünenthal, effective as of July 17, 2015,2015. The Amended MSA and together with the Amended License Agreement are referred to as the Amended Agreements.

Grünenthal has initially deployed the ZALVISO System in a limited number of hospitals in targeted countries under a pilot program, whereby the hospital will use ZALVISO in a small number of post-operative patients. Pilot programs are expected to last several months after which ZALVISO may be available for commercial sale. ZALVISO has been commercially launched in Germany, France, Belgium, Netherlands, Italy, the UK, Spain, Portugal and Austria, and is expected to be commercially launched in 2017 in Ireland. Royalty revenues and non-cash royalty revenues from the commercial sales of ZALVISO in the EU are expected to be minimal for 2017.

The Company has incurred recurring operating losses and negative cash flows from operating activities since inception.inception. Although ZALVISO has beenZalviso was approved for sale in the EU,Europe on September 18, 2015, the Company sold the majority of the royalty rights and certain commercial sales milestones it is entitled to receive under the Amended License Agreement with Grünenthal to PDL BioPharma, Inc., or PDL.PDL, in a transaction referred to as the Royalty Monetization. The FDA approved DSUVIA in November 2018 and the Company began its commercial launch of DSUVIA in the first quarter of 2019. As a result, the Company expects to continue to incur operating losses and negative cash flows.flows until such time as DSUVIA has gained market acceptance and generated significant revenues.

WhenExcept as the context otherwise requires, when we refer to "we," "our," "us," the "Company" or "AcelRx" in this document, we mean AcelRx Pharmaceuticals, Inc., and its consolidated subsidiary. “DZUVEO” is a trademark, and “ACELRX”, “DSUVIA” and “Zalviso” are registered trademarks, all owned by AcelRx Pharmaceuticals, Inc. This report also contains trademarks and trade names that are the property of their respective owners.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, ARPI LLC, which was formed in September 2015 for the sole purpose of facilitating the monetization transaction with PDL of the expected royalty stream and milestone payments due from the sales of ZALVISO in the European Union by its commercial partner, Grünenthal, pursuant to the Amended License Agreement, or the Royalty Monetization. All intercompany accounts and transactions have been eliminated in consolidation. Refer to Note 78 “Liability Related to Sale of Future Royalties” for additional information.

Reclassifications

Certain prior year amounts in the condensed consolidated financial statements have been reclassified to conform to the current year's presentation.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the rules and regulations of the U.S.United States. Securities and Exchange Commission, or SEC. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

Operating results for the three and nine months ended September 30, 2017,2019, are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.2019. The condensed consolidated balance sheet as of December 31, 2016,2018, was derived from the Company’s audited financial statements as of December 31, 2016,2018, included in the Company’s Annual Report on Form 10-K filed with the SEC. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2016,2018, which includes a broader discussion of the Company’s business and the risks inherent therein.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Management evaluates its estimates on an ongoing basis including critical accounting policies. Estimates are based on historical experience and on various other market-specific and other relevant assumptions that the Company believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.

Significant Accounting PoliciesInventories, net

The Company’s significant accounting policies are detailed in its Annual Report on Form 10-K for the year ended December 31, 2016. During the nine months ended September 30, 2017, there have been no significant changes to the Company’s significant accounting policies from those previously disclosed in its Annual Report on Form 10-K.

Recently Adopted Accounting Standards

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718), which is part of the FASB's Simplification Initiative. The updated guidance simplifies the accounting for share-based payment transactions. The amended guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, with early adoption permitted. Under this guidance, on a prospective basis, companies will no longer record excess tax benefits and certain tax deficiencies as additional paid-in capital. Instead, they will record all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement. In addition, the guidance eliminates the requirement that excess tax benefits be realized before companies can recognize them. The ASU requires a cumulative-effect adjustment for previously unrecognized excess tax benefits in opening retained earnings in the annual period of adoption. Effective January 1, 2017, the Company adopted this updated guidance. Upon adoption, the Company recognized additional excess tax benefit as a deferred tax asset with a corresponding increase to our deferred tax asset valuation allowance, which did not result in a net impact to retained earnings, and elected to recognize forfeitures when they occur using a modified retrospective approach, which did not have a material impact on its condensed consolidated financial statements.

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330) Related to Simplifying the Measurement of Inventory,which applies to all inventory measured using first-in, first-out (“FIFO”) or average cost. Inventory within the scope of the new guidance should be measuredInventories are valued at the lower of cost and net realizable value. NetCost is determined using the first-in, first-out method for all inventories. Inventory includes the cost of the active pharmaceutical ingredients, or API, raw materials and third-party contract manufacturing and packaging services. Indirect overhead costs associated with production and distribution are allocated to the appropriate cost pool and then absorbed into inventory based on the units produced or distributed, assuming normal capacity, in the applicable period. Indirect overhead costs in excess of normal capacity are recorded as period costs in the period incurred. DSUVIA was approved by the FDA in November 2018. Prior to FDA approval, all manufacturing costs for DSUVIA were expensed to research and development. Upon FDA approval, manufacturing costs for DSUVIA manufactured for commercial sale have been capitalized.

The Company's policy is to write down inventory that has become obsolete, inventory that has a cost basis in excess of its expected net realizable value and inventory in excess of expected requirements. The Company periodically evaluates the carrying value of inventory on hand for potential excess amount over demand using the same lower of cost or market approach as that used to value the inventory. Because the predetermined, contractual transfer prices the Company is receiving from Grünenthal are less than the estimated selling prices in the ordinary course of business, less reasonably predictabledirect costs of completion, disposal, and transportation. ASU No. 2015-11 was adopted by the Company beginning in fiscal 2017, and did not have a material impact on its condensed consolidated financial statements.manufacturing, all Zalviso inventories are carried at net realizable value.

Recently Issued Accounting StandardsLeases

In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting, to clarify which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting under ASC 718. Under the new guidance, an entity will not apply modification accounting to a share-based payment award if all of the following remain unchanged immediately before and after the change of terms and conditions:

•The award’s fair value (or calculated value or intrinsic value, if those measurement methods are used),

•The award’s vesting conditions, and

•The award’s classification as an equity or liability instrument.

ASU 2017-09 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017 for all entities. Early adoption is permitted, including adoption in any interim period for which financial statements have not yet been issued or made available for issuance. The ASU will be applied prospectively to awards modified on or after the adoption date. The Company does not expect the adoption of ASU 2017-09 to have a material effect on its results of operations, financial condition or cash flows.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. ASU No. 2016-18 is intended to reduce diversity in practice in the classification and presentation of changes in restricted cash on the condensed consolidated statement of cash flows. The ASU requires that the condensed consolidated statement of cash flows explain the change in total cash and equivalents and amounts generally described as restricted cash or restricted cash equivalents when reconciling the beginning-of-period and end-of-period total amounts. The ASU also requires a reconciliation between the total of cash and equivalents and restricted cash presented on the condensed consolidated statement of cash flows and the cash and equivalents balance presented on the condensed consolidated balance sheet. ASU 2016-18 is effective retrospectively on January 1, 2018, with early adoption permitted. The Company does not expect the adoption of ASU 2016-18 to have a material effect on its results of operations, financial condition or cash flows.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, addressing eight specific cash flow issues in an effort to reduce diversity in practice. The amended guidance is effective for fiscal years beginning after December 15, 2017, and for interim periods within those years. Early adoption is permitted. The Company does not expect the amended guidance to have a material impact on its statements of cash flows.

In February 2016, the FASB issued Accounting Standards Update, or ASU, No. 2016-02, Leases (Topic 842), which establishes a new lease accounting model for lessees.to enhance the transparency and comparability of financial reporting related to leasing arrangements. The updated guidance requiresCompany adopted the standard effective January 1, 2019.

At the inception of an entity to recognize assets and liabilities arising fromarrangement, the Company determines whether the arrangement is or contains a lease based on the unique facts and circumstances present. Operating lease liabilities and their corresponding right-of-use assets are recorded based on the present value of lease payments over the expected lease term. The interest rate implicit in lease contracts is typically not readily determinable. As such, the Company utilizes its incremental borrowing rate, which is the rate incurred to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. Certain adjustments to the right-of-use asset may be required for both financingitems such as initial direct costs paid or incentives received.

Lease expense is recognized over the expected term on a straight-line basis. Operating leases are recognized on the balance sheet as right-of-use assets, operating lease liabilities current and operating leases, alonglease liabilities non-current. As a result, the Company no longer recognizes deferred rent on the balance sheet.

Revenue from Contracts with additional qualitative and quantitative disclosures. The amended guidance is effective for fiscal years, and interim periods within those years, beginning after December 15,Customers

Beginning January 1, 2018, with early adoption permitted. Thethe Company has not yet selected a transition date, and is currently evaluatingfollowed the impactprovisions of the adoption of this standard on its condensed consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Accounting Standards Codification, or ASC, Topic 606, Revenue from Contracts with Customers,. The guidance provides a unified model to provide guidance ondetermine how revenue recognition. ASU No. 2014-09 requires a company to recognizeis recognized. The Company recognizes revenue when it transfersupon transfer of control of promised goodsproducts or services to customers in an amount that reflects the consideration to which the companyCompany expects to be entitledreceive in exchange for those products or services. The Company sells its products primarily through wholesale distributors.

In determining the appropriate amount of revenue to be recognized as it fulfills its obligations under its agreements, the Company performs the following steps: (i) identification of the promised goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. These may include identifyingservices in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the contract, estimatingcontext of the amountcontract; (iii) measurement of variable consideration to include in the transaction price, and allocatingincluding the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations based on estimated selling prices; and (v) recognition of revenue when (or as) the Company satisfies each separate performance obligation.

Net product sales revenue

Revenues from product sales are recognized when distributors obtain control of the Company’s product, which occurs at a point in time, upon delivery to such distributors. These distributors subsequently resell the product to certified medically supervised healthcare settings, such as hospitals, surgical centers, and emergency departments. In August 2015,addition to distribution agreements with these customers, the FASB issued ASU No. 2015-14, Company enters into arrangements with group purchasing organizations, or GPOs, and other certified medically supervised healthcare settings that provide for privately-negotiated discounts with respect to the purchase of its products. Revenue from Contracts with Customers (Topic 606): Deferralproduct sales is recorded at the transaction price, net of estimates for variable consideration consisting of distributor fees, GPO discounts, GPO administrative fees and returns. Variable consideration is recorded at the Effective Date,time product sales are recognized resulting in a reduction in product revenue. Variable consideration is estimated using the most-likely amount method, which provided foris the adoptionsingle-most likely outcome under a contract and is typically at the stated contractual rate. Actual amounts of consideration ultimately received may differ from the new standard for fiscal years beginning after December 15, 2017. Accordingly, ASU No. 2014-09 is effective forCompany’s estimates. If actual results vary materially from the Company’s estimates, the Company in the first quarter of 2018. Early adoption up to the first quarter of 2017 is permitted. Upon adoption, ASU No. 2014-09 can be applied retrospectively to all periods presented or only to the most current period presented with the cumulative effect of changes reflected in the opening balance of retainedwill adjust these estimates, which will affect revenue from product sales and earnings in the most current period presented. The FASB has also issued the following standards which clarify ASU No. 2014-09 and have the same effective date as the original standard:such estimates are adjusted. These estimates include:

The Company anticipates adoptionbelieves its estimated allowance for product returns requires a high degree of judgment and is subject to change based on its limited experience and certain quantitative and qualitative factors. The Company believes its estimated allowances for distributor fees, GPO discounts and GPO administrative fees do not require a high degree of judgment because the new standard effective January 1, 2018 underamounts are settled within a relatively short period of time.

Amounts accrued for product revenue allowances and related accruals are evaluated each reporting period and adjusted when trends or significant events indicate that a change in estimate is appropriate and to reflect actual experience. Product revenue-related liabilities are recorded in the modified retrospective transition method. The initial analysis identifying areas that will be impacted by the new guidance is substantially complete, and the Company is currently analyzing the potential impacts to theCompany’s condensed consolidated financial statements and related disclosures, including the areas of variable consideration and new disclosure requirements. While the Company is still in the process of its evaluation of its contract with the U.S. Department of Defense and the Amended Agreements with its collaboration partner Grünenthal, the Company currently believes that the impact of adoption of the new standard to its financial statements will not be material. As the Company completes its evaluation of the new standard, new information may arise that could change the Company’s understanding of the impact to its financial statements.balance sheets as Accrued liabilities. The Company will continue to monitorassess its estimates of variable consideration as it accumulates additional modifications, clarificationshistorical data and will adjust these estimates accordingly. Changes in product revenue allowance estimates could materially affect the Company’s results of operations and financial position.

Collaboration agreement revenue

The Company generates revenue from collaboration agreements. These agreements typically include payments for upfront signing or interpretations undertakenlicense fees, cost reimbursements for development and manufacturing services, milestone payments, product sales, and royalties on licensee’s future product sales.

Contract and other revenue

The Company entered into award contracts with U.S. Department of Defense, or the DoD, to support the development of DSUVIA. These contracts provided for the reimbursement of qualified expenses for research and development activities. Revenue under these arrangements was recognized when the related qualified research expenses were incurred. The Company was entitled to reimbursement of overhead costs associated with the study costs under the DoD arrangements. The Company estimated this overhead rate by utilizing forecasted expenditures. Final reimbursable overhead expenses were dependent on direct labor and direct reimbursable expenses throughout the life of each contract. The DoD Contract period of performance ended on February 28, 2019.

Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC Topic 606. The Company’s performance obligations include delivering product to its distributors, commercialization license rights, development services, services associated with the regulatory approval process, joint steering committee services, demo devices, manufacturing services, material rights for discounts on manufacturing services, and product supply.

The Company has optional additional items in contracts, which are considered marketing offers and are accounted for as separate contracts when the customer elects such options. Arrangements that include a promise for future commercial product supply and optional research and development services at the customer’s or the Company’s discretion are generally considered as options. The Company assesses if these options provide a material right to the licensee and if so, such material rights are accounted for as separate performance obligations. If the Company is entitled to additional payments when the customer exercises these options, any additional payments are recorded in revenue when the customer obtains control of the goods or services.

Transaction Price

The Company has both fixed and variable consideration. Variable consideration for product revenue is described as Net product sales in the condensed consolidated statements of comprehensive loss. For collaboration agreements, non-refundable upfront fees and product supply selling prices are considered fixed, while milestone payments are identified as variable consideration when determining the transaction price. Funding of research and development activities is considered variable until such costs are reimbursed at which point they are considered fixed. The Company allocates the total transaction price to each performance obligation based on the relative estimated standalone selling prices of the promised goods or services for each performance obligation.

At the inception of each arrangement that includes milestone payments, the Company evaluates whether the milestones are considered probable of being achieved and estimates the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant revenue reversal would not occur, the value of the associated milestone (such as a regulatory submission by the FASBCompany) is included in the transaction price. Milestone payments that may impact its current conclusions, and will expand its analysis to include any new revenue arrangements initiated prior to adoption.are not within the control of the Company, such as approvals from regulators, are not considered probable of being achieved until those approvals are received.

For arrangements that include sales-based royalties, including milestone payments based on the level of sales, and the license is deemed to be the predominant item to which the royalties relate, the Company recognizes revenue at the later of (a) when the related sales occur, or (b) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied).

Allocation of Consideration

As part of the accounting for collaboration arrangements, the Company must develop assumptions that require judgment to determine the stand-alone selling price of each performance obligation identified in the contract. Estimated selling prices for license rights and material rights for discounts on manufacturing services are calculated using an income approach model and can include the following key assumptions: the development timeline, sales forecasts, costs of product sales, commercialization expenses, discount rate, the time which the manufacturing services are expected to be performed, and probabilities of technical and regulatory success. For all other performance obligations, the Company uses a cost- plus margin approach.

Timing of Recognition

Revenues from product sales are recognized when distributors obtain control of the Company’s products, which occurs at a point in time, upon delivery to such distributors. Significant management judgment is required to determine the level of effort required under collaboration arrangements and the period over which the Company expects to complete its performance obligations under the arrangement. The Company estimates the performance period or measure of progress at the inception of the arrangement and re-evaluates it each reporting period. This re-evaluation may shorten or lengthen the period over which revenue is recognized. Changes to these estimates are recorded on a cumulative catch up basis. If the Company cannot reasonably estimate when its performance obligations either are completed or become inconsequential, then revenue recognition is deferred until the Company can reasonably make such estimates. Revenue is then recognized over the remaining estimated period of performance using the cumulative catch-up method. Revenue is recognized for products at a point in time when control of the product is transferred to the customer in an amount that reflects the consideration the Company expects to be entitled to in exchange for those product sales, which is typically once the product physically arrives at the customer, and for licenses of functional intellectual property at the point in time the customer can use and benefit from the license. For performance obligations that are services, revenue is recognized over time proportionate to the costs that the Company has incurred to perform the services using the cost-to-cost input method.

Cost of Goods Sold

Cost of goods sold for product revenue includes third party manufacturing costs, shipping costs, and indirect overhead costs associated with production and distribution which are allocated to the appropriate cost pool and recognized when revenue is recognized. Indirect overhead costs in excess of normal capacity are recorded as period costs in the period incurred.

Under the Amended Agreements with Grünenthal, the Company sells Zalviso to Grünenthal at predetermined, contractual transfer prices that are less than the direct costs of manufacturing and recognizes indirect costs as period costs where they are in excess of normal capacity and not realizable on a lower of cost or market basis. Cost of goods sold for Zalviso shipped to Grünenthal includes the inventory costs of API, third-party contract manufacturing costs, packaging and distribution costs, shipping, handling and storage costs, depreciation and costs of the employees involved with production.

Non-Cash Interest Income (Expense) on Liability Related to Sale of Future Royalties

In September 2015, the Company sold certain royalty and milestone payment rights from the sales of Zalviso in the European Union by its commercial partner, Grünenthal, pursuant to the Collaboration and License Agreement, dated as of December 16, 2013, as amended, to PDL for gross proceeds of $65.0 million, referred to as the Royalty Monetization. The Company continues to have significant continuing involvement in the Royalty Monetization primarily due to an obligation to supply Zalviso to Grünenthal. Under the relevant accounting guidance, because of the Company’s significant continuing involvement, the Royalty Monetization is accounted for as a liability that is being amortized using the effective interest method over the life of the arrangement. In order to determine the amortization of the liability, the Company is required to estimate the total amount of future royalty and milestone payments to be received by ARPI LLC and payments made to PDL, up to a capped amount of $195.0 million, over the life of the arrangement. The aggregate future estimated royalty and milestone payments (subject to the capped amount), less the $61.2 million of net proceeds the Company received, are amortized as interest expense over the life of the liability. Consequently, the Company imputes interest on the unamortized portion of the liability and records interest expense, or interest income, as estimates are updated related to the Royalty Monetization, accordingly.

There are a number of factors that could materially affect the amount and timing of royalty and milestone payments from Zalviso in Europe, most of which are not within the Company’s control. Such factors include, but are not limited to, the success of Grünenthal’s sales and promotion of Zalviso, changing standards of care, the introduction of competing products, manufacturing or other delays, intellectual property matters, adverse events that result in governmental health authority imposed restrictions on the use of Zalviso, significant changes in foreign exchange rates as the royalties remitted to ARPI LLC are made in U.S. dollars, and other events or circumstances that could result in reduced royalty payments from European sales of Zalviso, all of which may result in a reduction of non-cash royalty revenues and the non-cash interest expense over the life of the Royalty Monetization. Conversely, if sales of Zalviso in Europe are more than expected, the non-cash royalty revenues and the non-cash interest expense recorded by the Company would be greater over the term of the Royalty Monetization. The Company periodically assesses the expected royalty and milestone payments using a combination of historical results, internal projections and forecasts from external sources. To the extent such payments are greater or less than the Company’s initial estimates or the timing of such payments is materially different than its original estimates, the Company will prospectively adjust the amortization of the liability and the interest rate. Because estimated sales forecasts and payments may vary over the life of the Royalty Monetization, the Company may be required to recognize interest income as the imputed interest rate is adjusted prospectively to reflect the revised effective interest rate over the term of the Royalty Monetization.

The Company records non-cash royalty revenues and non-cash interest income (expense), within its condensed consolidated statements of comprehensive loss over the term of the Royalty Monetization.

When the expected payments under the Royalty Monetization are lower than the gross proceeds of $65.0 million received, the Company defers recognition of any probable contingent gain until the Royalty Monetization liability expires.

Significant Accounting Policies

The Company’s significant accounting policies are detailed in its Annual Report on Form 10-K for the year ended December 31, 2018. Aside from the adoption of ASU No. 2016-02, Leases (Topic 842) described below under “Recently Adopted Accounting Standards” and explained more fully above in “Leases,”and in Note 7 “Leases” below, there have been no significant changes to the Company’s significant accounting policies during the three and nine months ended September 30, 2019, from those previously disclosed in its 2018 Annual Report on Form 10-K.

Recently Adopted Accounting Standards

On August 29, 2018, the Financial Accounting Standards Board, or FASB, issued ASU No. 2018-15, “Intangibles – Goodwill and Other – Internal Use Software (Subtopic 350-40)”. The FASB’s new guidance aligns the requirements for capitalizing implementation costs in a Cloud Computing Arrangement, or CCA, service contract with the requirements for capitalizing implementation costs incurred for an internal-use software license.

The amendments in ASU No. 2018-15 require the entity to present the expense related to the capitalized implementation costs in the same line item in the statement of income as the fees associated with the hosting element (service) of the arrangement and classify payments for capitalized implementation costs in the statement of cash flows in the same manner as payments made for fees associated with the hosting element. The entity is also required to present the capitalized implementation costs in the statement of financial position in the same line item that a prepayment for the fees of the associated hosting arrangement would be presented.

ASU No. 2018-15 is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period for which financial statements have not been issued. Entities can choose to adopt the new guidance (1) prospectively to eligible costs incurred on or after the date this guidance is first applied or (2) retrospectively. The Company early adopted ASU No. 2018-15 effective January 1, 2019 under the prospective method, which did not have a material effect on the Company’s results of operations, financial condition or cash flows.

In August 2018, the SEC published Release No. 33-10532, Disclosure Update and Simplification, or DUSTR, which adopted amendments to certain disclosure requirements that have become redundant, duplicative, overlapping, outdated or superseded, in light of other SEC disclosure requirements, U.S. Generally Accepted Accounting Principles, or GAAP, or changes in the information environment. While most of the DUSTR amendments eliminate outdated or duplicative disclosure requirements, the final rule amends the interim financial statement requirements to include a reconciliation of changes in stockholders’ equity (deficit) in the notes or as a separate statement for each period for which a statement of comprehensive income (loss) is required to be filed. The new interim reconciliation of changes in stockholders’ equity (deficit) is included herein as a separate statement.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which establishes a new lease accounting model for lessees. In January, July and December 2018, the FASB issued additional amendments to the new lease guidance relating to, transition, and clarification. The July 2018 amendment, ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, provided an optional transition method that allows entities to elect to apply the standard prospectively at its effective date, versus recasting the prior periods presented. The new standard establishes a right-of-use, or ROU, model that requires a lessee to record an ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Disclosure requirements have been enhanced with the objective of enabling financial statement users to assess the amount, timing, and uncertainty of cash flows arising from leases. ASU No. 2016-02 became effective for the Company on January 1, 2019. The Company has implemented the standard using an optional transition method that allows the Company to initially apply the new leases standard as of the adoption date and recognize a cumulative-effect adjustment to the opening balance of accumulated deficit in the period of adoption. In connection with the adoption, the Company has elected to utilize the package of practical expedients, including: (1) not reassess the lease classification for any expired or existing leases, (2) not reassess the treatment of initial direct costs as they related to existing leases, and (3) not reassess whether expired or existing contracts are or contain leases. In addition, the Company elected the hindsight practical expedient to determine the lease term for existing leases. The election of the hindsight practical expedient resulted in the extension of the lease term for the Company’s embedded lease.

The adoption of the new leases standard resulted in the following adjustments to the condensed consolidated balance sheet as of January 1, 2019 (in thousands):

The adoption of ASU No. 2016-02, the new leases standard, did not impact previously reported financial results because the impact to prior periods was reflected as a cumulative-effect adjustment to the accumulated deficit under the optional transition method.

Recently Issued Accounting Standards

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments,” or ASU 2016-13. ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for the Company beginning January 1, 2023, with early adoption allowed beginning January 1, 2020. In May 2019, the FASB issued ASU 2019-05, “Financial Instruments – Credit Losses”, or ASU 2019-05, to allow entities to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost upon adoption of the new credit losses standard. The new effective dates and transition align with those of ASU 2016-13. Management is currently assessing the date of adoption and the impact ASU 2016-13 and ASU 2019-05 will have on the Company, but it does not anticipate adoption of these new standards to have a material impact on the Company’s financial position, results of operations and cash flows.

2. Investments and Fair Value Measurement

Investments

The Company classifies its marketable securities as available-for-sale and records its investments at fair value. Available-for-sale securities are carried at estimated fair value based on quoted market prices or observable market inputs of almost identical assets, with the unrealized holding gains and losses included in accumulated other comprehensive income. Marketable securities which have maturities beyond one year as of the end of the reporting period are classified as non-current.

The table below summarizes the Company’sCompany’s cash, cash equivalents and investments (in thousands):

As of September 30, 20172019 and December 31, 2016,2018, none of the available-for-sale securities held by the Company had material unrealized losses. There were no other-than-temporary impairments for these securities at September 30, 20172019 or December 31, 2016.2018. No gross realized gains or losses were recognized on the available-for-sale securities and, accordingly, there were no amounts reclassified out of accumulated other comprehensive income to earnings during the three and nine months ended September 30, 20172019 and 2016.September 30, 2018.

As of September 30, 20172019 and December 31, 2016,2018, the contractual maturity of all investments held was less than one year.

Fair Value Measurement

The Company’sCompany’s financial instruments consist of Level I and II assets and Level III liabilities. Money market funds are highly liquid investments and are actively traded. The pricing information on these investment instruments are readily available and can be independently validated as of the measurement date. This approach results in the classification of these securities as Level 1 of the fair value hierarchy. For Level II instruments, the Company estimates fair value by utilizing third party pricing services in developing fair value measurements where fair value is based on valuation methodologies such as models using observable market inputs, including benchmark yields, reported trades, broker/dealer quotes, bids, offers and other reference data. Such Level II instruments typically include U.S. treasury, and U.S. government agency obligations.securities and commercial paper. As of September 30, 2017 and December 31, 2016,2019, the Company held, in addition to Level II assets, a contingent put option liability associated with the Company’s Amended and Restated Loan and Security Agreement, or the Original Loan Agreement, with Hercules Technology II, L.P. and Hercules Capital, Inc., formerly known as Hercules Technology Growth Capital, Inc., collectively referred to as the Lenders, which amended and restated the Loan and Security Agreement datedOxford Finance LLC, or Oxford. Similarly, as of June 29, 2011, which was classified as a Level III liability. On March 2, 2017,December 31, 2018, the Company entered into anheld a contingent put option liability associated with the Amended and Restated Loan and Security Agreement, or the Amended Loan Agreement, or Prior Agreement, with Hercules Capital Funding Trust 2014-1 and Hercules Technology II, L.P., together, Hercules. The Amended Loan Agreement amends and restates the Original Loan Agreement. See Note 6 “Long-Term Debt” for further description. The Company’s estimate of fair value of each of the contingent put option liabilityliabilities was determined by using a risk-neutral valuation model, wherein the fair value of the underlying debt facility is estimated both with and without the presence of the default provisions, holding all other assumptions constant. The resulting difference between the two estimated fair values is the estimated fair value of the default provisions, or the contingent put option.option, which is included under other long-term liabilities on the condensed consolidated balance sheets. Changes to the estimated fair value of these liabilities are recorded in interest income and other income, (expense), net in the condensed consolidated statements of comprehensive loss. The fair value of the underlying debt facility is estimated by calculating the expected cash flows in consideration of an estimated probability of default and expected recovery rate in default and discounting such cash flows back to the reporting date using a risk-free rate.

As of September 30, 2017 and December 31, 2016, the Company also held a Level III liability associated with warrants, or PIPE warrants, issued in connection with the Company’s private placement equity offering, completed in June 2012. For a detailed description, see Note 8 “Warrants.” The PIPE warrants are considered a liability and are valued using the Black-Scholes option-pricing model, the inputs for which include exercise price of the PIPE warrants, market price of the underlying common shares, expected term, volatility based on a group of the Company’s peers and the risk-free rate corresponding to the expected term of the PIPE warrants. Changes to any of these inputs can have a significant impact to the estimated fair value of the PIPE warrants. The following table sets forth the fair value of the Company’s financial assets and liabilities by level within the fair value hierarchy (in thousands):

The following table sets forth the assumptions used in the Black-Scholes option-pricing model to estimate the fair value of the PIPE warrants as of September 30, 2017 and December 31, 2016:

The following tables set forth a summary of the changes in the fair value of the Company’sCompany’s Level III financial liabilities for the three and nine months ended September 30, 20172019 and September 30, 20162018 (in thousands):